Vigil Health is the subject of my first post. Vigil trades on the TSX-Venture exchange and is relatively illiquid given the market capitalization is C$15 million. I reiterate the following post is not meant to be investment advice, but rather some thoughts around a quality small/micro cap company. I have provided some work on valuation for my own reference.
- Vigil’s core end-market (senior housing) will likely be under continued pressure to cut costs over the coming years due to there being a single dominant payer (Medicaid). Medicaid itself will be under pressure to reduce costs to help stem the massive US federal deficit.
- Vigil is in a unique position to help the industry save money by offering a lower-cost nurse call and wander management (ie. memory care) system. Vigil is able to offer a lower cost solution because:
- Vigil offers a bundled nurse call and memory care system. Other providers have nurse call and need to partner to provide memory care which implies two layers of margin and a higher cost to the customer.
- Vigil focuses on the senior housing market. Many providers have a focus on the hospital market which requires higher end systems with more integration capabilities. As a result, these competitor systems have a higher cost.
- Vigil sells through its direct sales force to large corporate customers. Many providers sell through distribution, which again implies another layer of margin and higher cost to the customer.
- Vigil is a small company with limited overhead. A Government of Canada website discloses there is only 17 employees. Linkedin says 27 employees. Either way, it is small!
- Recent share price weakness has been due to a slowdown in revenue growth that first happened when Vigil reported Q1/FY18 results in August 2017. This revenue slowdown is expected to be temporary because:
- Both bookings and backlog are currently strong which signal future revenue growth.
- Vigil operates in a very large market and there is room for deeper penetration.
- There is lots of opportunity for Vigil to broaden its product offering and expand into adjacencies.
- Chairman Greg Peet owns 28% of shares outstanding. Peet has a strong track record having sold A.L.I. Technologies to Mckesson and Contigo Systems to Vecima Networks.
- Strong balance sheet with $1.9 million of cash and no debt. Vigil has been cash generative in each of the past 5 years.
- Valuation is reasonable at about 15x FY17 earnings.
What they do (ie. the basics)?
Vigil focuses on software solutions for the North American senior housing market. The company has a system used for patient monitoring that enables emergency and nurse calls. Its marquee offering is used for patients with memory impairment or dementia. These patients are unable to use a traditional method of pushing a button or pulling a string to call a nurse. Vigil provides software and associated sensors to monitor patients in a non-invasive manner and alert nurses when their patterns of behavior or movement are not normal.
It is important to begin any discussion about a company with thoughts about the industry. As Warren Buffet famously noted, “I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
Vigil serves the senior housing market. The two key drivers of the senior housing market will be: 1) number of seniors, and 2) price paid per a senior.
Number of Seniors: The aging of the boomers will contribute a tailwind to the industry for many years to come. This can be seen in two charts from the US Census Bureau. The first chart shows the growth rate of people aged 65+ versus the growth rate of the total population. The population aged 65+ is projected to grow at a much faster rate than the total population between 2010 and 2030. The second chart shows the history and projected future of the total population aged 85+. The number of people over 85 in the USA is projected to grow from roughly 5.7M in 2010 to 9.0M in 2030 (annual growth rate of 2.3%).
Price paid per Senior: From a pricing perspective, the overall health of the industry is more uncertain. This is because of the very high costs associated with Nursing homes and the dominant role that Medicaid plays in paying for these costs. Genworth (an insurer) notes that the median price for a private room in a long-term care facility now totals $90,000 on an annual basis. The Kaiser Family Foundation notes that 64% of nursing home residents receive coverage from Medicaid. This is an astronomical number. In 2015, Medicaid spent a total of $54 bn on nursing facilities. Nursing facilities are part of a broader bucket of Medicaid spending called Long-Term Services and Supports (LTSS) which includes Home and Community Base Services (HCBS). In 2015, a total of $158 bn was spent by Medicaid on LTSS.
When looking at the total LTSS Medicaid spend bucket, an interesting divergence has occurred over the past 15 years. While total spending has increased, it has been almost entirely driven by HCBS. The institutional bucket of spend (which includes nursing homes) has shown very little dollar growth (see chart below). My interpretation is that there has been pressure to reduce spend in high-cost facilities or environments (ie. nursing homes) and transfer that spend to lower cost environments (ie. home-based care).
The providers of senior housing have adapted to the pressure on nursing home spending by altering the mix of units being constructed. There has been a growing number of independent living units (ILU) and assisted living units (ALU), while the number of nursing care beds (NCB) has been relatively flat. There has also been growth in Continuing Care Retirement Communities which are aimed at providing the full continuum of care all within a single community. Note that the data in the chart below is from a joint publication by Ziegler (a specialty investment bank) and Leading Age of the top 150 non-profit providers of senior housing. It is likely the trend would be even more pronounced if for-profit providers were included.
In summary, while senior housing is expected to benefit from the continued aging of the population, there will likely be continuing pressure to cut costs given the dynamic of having a single dominant payer (Medicaid). Medicaid can use its scale to pressure a fragmented supply-base into pricing concessions. The pressure will likely be continuous as Medicaid itself will also fall under pressure to cut costs to help cope with ever-mounting budget deficits in the United States (note that Medicaid is the third largest domestic program in the federal budget after Social Security and Medicare).
This dynamic has the potential to be positive for technology providers such as Vigil. The three largest costs for a senior housing provider are labor, food, and utilities. Technology has the potential to increase productivity and bring down labor costs over time.
Vigil has three core products: a wired nurse call system, a wireless call system, and a memory care system. The core function of all three products is the same; to allow patients to communicate with their caregivers in case of discomfort, pain or emergency. From a broad perspective, Vigil competes with all Nurse Call providers.
However, one way in which Vigil differentiates itself versus other nurse call competitors is its singular focus on senior housing. Many of its other competitors have a “hospital first” mentality. According to Centers for Medicare and Medicaid Services (CMS.gov), total healthcare spending in the United States was $3.3 trillion in 2016 (18% of United States GDP!). Of this amount, 32% or $1.1 trillion of spending was attributable to hospital care. Only 5% or $163 billion was attributed to Nursing Care Facilities and Continuing Care Retirement communities. The much larger spending in the hospital setting naturally attracts more and larger competitors, while senior housing is neglected.
The neglect of the senior housing sub-segment can be seen in the actions of some of the large Nurse Call competitors. At a 2014 conference held by Piper Jaffray, Hill-Rom disclosed that the economics in the States for long-term care, nursing home facilities have not been terribly attractive, and as a result they do not have a lot of business in the nursing home end market. 3M seems to concur with this statement as demonstrated by its abrupt exit of its Homefree or its resident monitoring product line in 2013. It’s also worth noting that only two of the six top nurse call providers had a presence at the Argentum conference which is one of the largest conferences for companies that own operate and support professionally managed senior living communities. Tektone and Ascom had a presence, while Elpas (Tyco), Rauland (Ametek), Jeron and West-Com did not have any presence (indicating they are not actively targeting senior living).
Of the two competitors with a presence at Argentum, it is worth noting: 1) Tektone does not actually provide wander management solutions for seniors with dementia itself; it partners with Accutech, and 2) Ascom is a large company with a focus both in Europe and hospitals. Given the relative size, Vigil can provide much better service (no bureaucracy) than Ascom while providing a solution that is tailored to senior housing rather than hospitals. The complexity of care at hospitals is much higher and Ascom has spent a lot of resources (that it looks to get paid for) on integrations which are not necessary at a nursing home.
I believe that Vigil has carved out a unique niche for itself by focusing on the senior housing market. Given its small size and limited overhead, Vigil can effectively compete by offering senior housing providers a lower cost versus its larger competitors focused on serving more complex needs of a hospital. Cost is very important to providers of senior housing given the industry-wide pressure to reduce costs as a result of there being a dominant payer (Medicaid). Medicaid is able to use its scale and ability to benchmark against best-in-class providers to reduce payments to senior housing providers meaning that the cost of any technology solution is a decisive factor when deciding which technology vendor to select. Vigil can also offer a better cost than competitors who have to find partners to be able to provide nurse call and wander management. Vigil only has a single layer of margin whereas competitors who partner must split the profit between two or more parties.
New Customers: Based on Vigil’s ongoing disclosure, it is difficult to assess new customer acquisition. Vigil groups project revenue from both new and existing customers together in the same bucket. However, we can gauge Vigil’s current level of penetration given its disclosure that its installed base consists of over 500 projects representing more than 38,000 beds.
The key question is what to use as an addressable market. According to Ziegler (a senior housing focused investment bank), there are a total of 1,060 Memory Care communities in the United States with a total of 51,000 beds. If we assumed that Vigil’s addressable market only consisted of Memory Care communities, this would imply Vigil has nearly fully penetrated the market in the United States.
However, this would be a mistake as Vigil does not just serve memory care. Vigil provides solutions across the care continuum so as to have an offering for each level of care in a Continuing Care Retirement Community. In total, when looking at independent living, assisted living, and nursing homes, there are roughly 3.2 million units across the united states (Source: Ziegler). This would imply a much lower penetration of 1.2%.
My thinking is that neither one of these numbers is right. Vigil’s core opportunity really lies in communities that have both memory care and other forms of senior housing (ie. combination of independent, assisted and nursing home). Most of Vigil’s sales come through its direct sales force. Due to its limited number of employees, it only makes sense from a resource and cost perspective for Vigil to target large providers of senior housing with a mix of housing options across the care continuum.
Existing Customer Penetration: Vigil also has an opportunity to increase spending from existing customers. As a whole, software and IT is relatively under-developed within senior housing. There are two points that support this: 1) A survey from Zeigler found that only 21% of organizations had a Chief Information/Technology Officer position, and 2) Only 20% of residential care communities use electronic health records (source: Getting to 2025: A Senior Living Roadmap; Argentum).
Vigil has demonstrated an ability to adapt its offering to appeal to adjacent markets. Vigil started off specializing in only Memory Care for skilled nursing facilities. Over time, Vigil has added additional systems so that it can offer a Nurse Call product. The company has also added systems to expand into assisted living and independent living facilities (with lower levels of care relative to a nursing home).
To date, Vigil has focused all of its software on the interaction between the resident and the onsite nurse or caregiver. There are many other interactions at a senior housing facility where technology has applications:
- Interaction between caregivers on the ‘front line’ and the attending or primary physician doctor. This would likely entail automation of relevant information into the residents’ Electronic Health Record. Could also include things like Electronic Medication Administration Records (eMAR) and electronic treatment authorization requests (eTAR).
- Interaction between nurses and administrators. This could entail a real-time locating service to monitor the movements of nurses and time spent with each patient. This would allow administrators to monitor the productivity and utilization of nurses (to help with scheduling) as well as have applications with billing (ie. patients who require the most time from a nurse are charged more).
- Interaction between residents and their families. This could include monitoring of health, or activity with automated communication/notification sent to family on an opt-in basis. It could also monitor what are known as activities for daily living, such as eating, dressing, bathing (by putting sensors on things like fridge, closet, shower) and alert family members when an increased level of care may be needed (ie. a move from assisted living to nursing home).
A strong balance sheet is essential for very small companies like Vigil. Small companies have a much more difficult time accessing capital markets than large companies. Some hedge funds will search for small/micro caps in search of funding and go short the stock so that they can buy it back on an upcoming share issuance.
Vigil’s balance sheet is solid with a cash balance of $1.9 million and no debt.
It is worth noting that Vigil has an accumulated deficit of $12.4 million on its balance sheet. This means that company has lost more money than it has made over its history. While this can be a troublesome sign, it is worth noting that Vigil has been profitable in each of the past five years (starting in FY13).
I am not worried about the accumulated deficit because Vigil is a software company. This means its capital expenditures are very low. A large reason for the accumulated deficit are R&D costs that have been expensed as incurred. The company recognizes costs related to R&D before it is able to sell the software to customers and receive revenue. Another reason for the deficit is that Vigil was too aggressive on sales and marketing expense when Vigil first IPO’d (between FY03 and FY06). The company scaled back its sales and marketing in FY07 and concentrated on specific geographies where it had success rather than full nationwide coverage.
Return on Capital
Vigil is currently reinvesting most of its money into R&D and sales and marketing. When the company gets to a larger scale, it will earn a very high return on capital because of the lack of fixed assets in the business. Vigil has tangible assets of $2.0 million which are mostly comprised of accounts receivable, inventories, and contracts in progress. There is about $1.2 million of deferred revenue (cash received from customers in advance of billing) and $0.5 million of A/P so invested capital is very low at only about $0.3 million.
This begs the obvious question; why would new competitors not enter and drive down returns on capital given the invested capital in the business is so low? The answer is that Vigil has accumulated significant expense related to R&D and developing its sales force and brand. Over the past 10 years, Vigil has spent $4M on R&D and $8M on sales and marketing.
Board and Management
Management’s interests appear to be aligned with shareholders given the chairman owns a large chunk of the company and the CEO draws a modest base salary.
The chairman of the board, Greg Peet, is an experienced entrepreneur. Peet made his name for himself by selling A.L.I. Technologies to Mckesson for $526 million. A.L.I. was a medical imaging company tat Peet grew from 14 employees in 1993 to over US$100 million in revenue per annum. Peet was also a part of Contigo Systems which was sold to Vecima networks. There is a quote from a Financial Post article about Peet that stands out, “Early-stage ventures have to be too early to a market,” he says. “If you build a product when every other company is doing it, bigger companies will have more resources and you’ll be too late.” One has to wonder if Vigil is taking a page from Peet’s playbook by focusing on the Senior Care market while the other major nurse call providers focus on the larger hospital market. Peet’s interests are aligned with shareholders as he owns 29% of Vigil’s shares outstanding.
Troy Griffiths has been the CEO of Vigil since March 2005. He is an accountant by trade. Troy Griffiths owns 611,000 shares. He draws a relatively modest base salary of $150,000 and his total compensation package was $235,000 in the year ended March 31, 2017.
Vigil issued 394,000 options at it AGM in 2017. This represents approx. 2% of the share base. While this seems a bit high, Vigil’s market capitalization is only $12M which necessitates a rather large option grant to pay its executives fairly. It is worth noting that the strike price on the options were the same price as the closing price on the day they were granted. This is a sign of good governance as TSX Venture exchange rules allow corporate issuers to grant options with a strike price up to 25% below the closing price on the day of the grant.
Recent Share Price Movement
Vigil has most recently traded at $0.85 per share which is down significantly from its Aug 15, 2017 peak of $1.20. Vigil operates on a March 31st year-end. The company reported its first quarter of FY18 on the same day that Vigil’s share price peaked (implying the market was unhappy with the results).
What was so bad about the quarter? Revenue in the quarter was $1.49 million versus $1.66 million in Q1/FY17, representing a decline of 10%. Vigil increased its gross margin in Q1/FY18 (55% vs 52% in prior year), but this was more than offset by increased payroll related to administration, R&D, and sales and marketing. Operating income was down 56% year over year as a result of higher expenses on a lower revenue basis.
While these headline numbers seem weak, there are a few things worth point out. The first being that FY17 was a very strong year for Vigil, meaning the company was facing a tough comparison. Revenue in FY17 was up 40% y/y, while revenue in Q1 of FY17 was up 30% y/y. A second point is that while revenue was down, bookings (an indicator of future revenue) were up 38% y/y to $1.85 million, from $1.34 million.
The last point is that Vigil reported Q2/FY8 results on Nov 14, 2017. Vigil managed to increase revenue 2% y/y in the quarter to $1.61 million. It is worth noting that Q2/FY17 revenue for Vigil was up 70%, so again the company was facing a tough comp. Bookings were up 37% to $1.93 million in Q2/FY18. Backlog now sits at $3.23M due to the strong bookings, and is up significantly from the low point of $2.44 million which was reported with the Q4/FY17 results.
A key point in all of this is that quarterly results can be very volatile for Vigil. The root cause is that Vigil’s revenue is made up of a split of large projects and service/maintenance/replacement billings. The large projects are not booked into revenue until the installation is complete and the customer signs off that performance obligations have been met. This creates a lumpy stream of revenue that is rather volatile for Vigil (see chart below).
Vigil’s revenue from maintenance/service/repair sales is much more stable and has been growing each year. When Vigil sells a system, it includes one-year of warranty and support (24 hr emergency client support by telephone). After the first year, facilities can purchase support and maintenance for somewhere in the range of 10% to 20% of the original price. The benefit of purchasing ongoing maintenance is that the facility gets access to the support center, software upgrades, and revisions to training and technical documentation.
The last chart puts the recent top-line weakness into context. The red-line is revenue on a trailing twelve month basis (TTM). While the trend has flattened out, this does not appear unusual relative to Vigil’s historical performance. I do not think the flat year over year revenue growth is a sign of impairment to Vigil’s ability to successfully compete in the market. Vigil’s actions appear to support this statement. Vigil is a very small company. A government of Canada website discloses that Vigil only has 17 employees. For a company this small, hiring new employees is a crucial decision and signals internal confidence in the future of the confidence. Vigil has been hiring recently as demonstrated by its higher expenses. The company also recently had a job opening for a business development associate; again signaling future confidence in the business.
Vigil currently has 17.7 million shares outstanding and recently traded at a share price of $0.85 for a market capitalization of $15 million. Vigil’s IFRS net income in FY17 was $2.1 million which is a very low P/E ratio of 7x. However, $1.1 million of net income was related to an income tax recovery. If we exclude this amount, the P/E ratio would be ~15x, which is still cheap for a company with VGL’s growth potential (and in the context of the current stock price environment).
Given that Vigil is early in its development, it is worth estimating what VGL could potentially trade at in the future.
I think in order to invest in Vigil, you must believe that the revenue growth slowdown is temporary. I think it is reasonable to assume Vigil can grow revenue at an average of 10% over the next 5 years. This implies Vigil can grow its revenue from $6.8 million in FY17 to $10.9 million five years out. Over the past 3, 5 and 7 year periods, Vigil has grown revenue at 10%, 15% and 8%, respectively.
If we add a few other estimates to our revenue estimate, we can forecast an EPS number five years out:
- Gross margin of 50% versus FY17 of 51% and five year historical average of 50%
- G&A as % of sales of 11% versus FY17 level of 15% and five year historical average of 19%. I am implicitly assuming this is mostly comprised of fixed costs (ie. CEO’s salary, audit fees, etc.) that will stay fixed as the company grows its top-line.
- R&D as % of sales of 8% versus FY17 level of 7% and five year historical average of 8.5%.
- Sales and marketing as % of sales of 15% versus FY17 level of 15% and five year historical average of 19%.
- Tax rate of 26% (Vigil’s combined federal and provincial statutory rate). This is relative to tax recovery in FY17 and no taxes paid over the past five years.
- Share count increases at a rate of 2% a year to account for stock-based compensation.
The net result of these assumptions is an EPS forecast of $0.07. It is worth noting that the assumption that Vigil has to start paying taxes is a key reason for why this $0.07 EPS forecast is not higher. A 15x multiple on $0.07 would imply a share price of $1.01. While a 20x multiple would imply a share price of $1.34.
If we are more optimistic and assume 15% top-line growth, implied share price at a 15x multiple is $1.44 and at a 20x multiple implied share price is $1.92.
If we are more pessimistic and assume top-line growth of 5%, implied share price at a 15x multiple is $0.64 and $0.86 at a 20x multiple.
Note that these share price forecasts do not take into account the time value of money and are simply meant to illustrate where Vigil’s shares could trade 5 years out from now.
I’d also note that I have tried to outline reasonable valuation and growth scenarios. This comes at a time when the market is willing to price many stocks at unreasonable levels. One example is Veeva Software which is trading at above 10x sales. Ascom who is one of Vigil’s larger competitors trades at 3x sales. While I am not suggesting that Vigil should be valued at the same multiple as a SaaS company (due to a revenue mix that includes hardware and services, and not just software), I do think it illustrates how highly valued some equities currently are. 3x Vigil’s projected sales of $10.9M would suggest a share price of $1.75, while 5x would suggest $2.91.
The Company’s website: http://www.vigil.com/
Author Ownership: Yes TSXV: VGL
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